21.4 Review and Practice


This chapter focused on the measurement of GDP. The total value of output (GDP) equals the total value of income generated in producing that output (GDI). We can illustrate the flows of spending and income through the economy with the circular flow model. Firms produce goods and services in response to demands from households (personal consumption), other firms (private investment), government agencies (government purchases), and the rest of the world (net exports). This production, in turn, creates a flow of factor incomes to households. Thus, GDP can be estimated using two types of data: (1) data that show the total value of output and (2) data that show the total value of income generated by that output.

In looking at GDP as a measure of output, we divide it into four components: consumption, investment, government purchases, and net exports. GDP equals the sum of final values produced in each of these areas. It can also be measured as the sum of values added at each stage of production. The components of GDP measured in terms of income (GDI) are employee compensation, profits, rental income, net interest, depreciation, and indirect taxes.

We also explained other measures of income such as GNP and disposable personal income. Disposable personal income is an important economic indicator, because it is closely related to personal consumption, the largest component of GDP.

GDP is often used as an indicator of how well off a country is. Of course, to use it for this purpose, we must be careful to use real GDP rather than nominal GDP. Still, there are problems with our estimate of real GDP. Problems encountered in converting nominal GDP to real GDP were discussed in the previous chapter. In this chapter we looked at additional measurement problems and conceptual problems.

Frequent revisions in the data sometimes change our picture of the economy considerably. Accounting for the service sector is quite difficult. Conceptual problems include the omission of nonmarket production and of underground and illegal production. GDP ignores the value of leisure and includes certain “bads.”

We cannot assert with confidence that more GDP is a good thing and that less is bad. However, real GDP remains our best single indicator of economic performance. It is used not only to indicate how any one economy is performing over time but also to compare the economic performance of different countries.

Concept Problems

  1. GDP is used as a measure of macroeconomic performance. What, precisely, does it measure?
  2. Many economists have attempted to create a set of social accounts that would come closer to measuring the economic well-being of the society than does GDP. What modifications of the current approach would you recommend to them?
  3. Every good produced creates income for the owners of the factors of production that created the product or service. For a recent purchase you made, try to list all the types of factors of production involved in making the product available, and try to determine who received income as a result of your purchase.
  4. Explain how the sale of used textbooks in your campus bookstore affects the GDP calculation.
  5. Look again at the circular flow diagram in Figure 21.5 “Spending in the Circular Flow Model” and assume it is drawn for the United States. State the flows in which each of the following transactions would be entered.

    1. A consumer purchases fresh fish at a local fish market.
    2. A grocery store acquires 1,000 rolls of paper towels for later resale.
    3. NASA purchases a new Saturn rocket.
    4. People in France flock to see the latest Brad Pitt movie.
    5. A construction firm builds a new house.
    6. A couple from Seattle visits Guadalajara and stays in a hotel there.
    7. The city of Dallas purchases computer paper from a local firm.
  6. Suggest an argument for and an argument against counting in GDP all household-produced goods and services that are not sold, such as the value of child care or home-cooked meals.
  7. Suppose a nation’s firms make heavy use of factors of production owned by residents of foreign countries, while foreign firms make relatively little use of factors owned by residents of that nation. How does the nation’s GDP compare to its GNP?
  8. Suppose Country A has the same GDP as Country B, and that neither nation’s residents own factors of production used by foreign firms, nor do either nation’s firms use factors of production owned by foreign residents. Suppose that, relative to Country B, depreciation, indirect business taxes, and personal income taxes in Country A are high, while welfare and Social Security payments to households in Country A are relatively low. Which country has the higher disposable personal income? Why?
  9. Suppose that virtually everyone in the United States decides to take life a little easier, and the length of the average workweek falls by 25%. How will that affect GDP? Per capita GDP? How will it affect economic welfare?
  10. Comment on the following statement: “It does not matter that the value of the labor people devote to producing things for themselves is not counted in GDP; because we make the same ‘mistake’ every year, relative values are unaffected.”
  11. Name some of the services, if any, you produced at home that do get counted in GDP. Are there any goods you produce that are not counted?
  12. Marijuana is sometimes estimated to be California’s largest cash crop. It is not included in estimates of GDP. Should it be?

Numerical Problems

  1. Given the following nominal data, compute GDP. Assume net factor incomes from abroad = 0 (that is, GDP = GNP).

    Nominal Data for GDP and NNP $ Billions
    Consumption 2,799.8  
    Depreciation 481.6
    Exports 376.2
    Gross private domestic investment 671.0
    Indirect taxes 331.4
    Government purchases 869.7
    Government transfer payments 947.8
    Imports 481.7
  2. Find data for each of the following countries on real GDP and population. Use the data to calculate the GDP per capita for each of the following countries:

    1. Mozambique
    2. India
    3. Pakistan
    4. United States
    5. Canada
    6. Russia
    7. Brazil
    8. Iran
    9. Colombia
  3. Now construct a bar graph showing your results in the previous problem, organizing the countries from the highest to the lowest GNP per capita, with countries on the horizontal axis and GNP per capita on the vertical axis.
  4. Suppose Country A has a GDP of $4 trillion. Residents of this country earn $500 million from assets they own in foreign countries. Residents of foreign countries earn $300 million from assets they own in Country A. Compute:

    1. Country A’s net foreign income.
    2. Country A’s GNP.
  5. Suppose a country’s GDP equals $500 billion for a particular year. Economists in the country estimate that household production equals 40% of GDP.

    1. What is the value of the country’s household production for that year?
    2. Counting both GDP and household production, what is the country’s total output for the year?
  6. A miner extracts iron from the earth. A steel mill converts the iron to steel beams for use in construction. A construction company uses the steel beams to make a building. Assume that the total product of these firms represents the only components of the building and that they will have no other uses. Complete the following table:

    Company Product Total Sales Value Added
    Acme Mining iron ore $100,000 ?
    Fuller Mill steel beams $175,000 ?
    Crane Construction building $1,100,000    ?
    Total Value Added ?
  7. You are given the data below for 2008 for the imaginary country of Amagre, whose currency is the G.

    Consumption 350 billion G
    Transfer payments 100 billion G
    Investment 100 billion G
    Government purchases 200 billion G
    Exports 50 billion G
    Imports 150 billion G
    Bond purchases 200 billion G
    Earnings on foreign investments 75 billion G
    Foreign earnings on Amagre investment 25 billion G
    1. Compute net foreign investment.
    2. Compute net exports.
    3. Compute GDP.
    4. Compute GNP.


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